PSS: Keeping the Faith vs. Throwing in The Flag

OK. So do you go all-in, or throw in the towel? That’s the question that most holders of PSS will be thinking today. Though it’s not in our portfolio, this is definitely a name I’ve liked, and have been warming towards recently, so I am definitely in the same camp. Here’s a few notables…
Reasons to consider throwing in the towel
1) PSS missed both the Street’s and my estimate (-$0.44, and -$0.36, respectively) by a mile. Losing $0.54 with such negative momentum is not exactly indicative of being one of the ‘winners’ in this climate.

2) It’s been over a year since the Stride Rite acquisition, and over 2-years since this management team hit stride in its strategy to regain control of the consumer and grow the business. At some point sooner than later, we need to draw a line in the sand and expect results.

3) ‘Consumer connection’ has never been higher per Payless’ internal scoring system, but what good is that if we’re not seeing it in numbers?

4) Costs out of China are higher than the company guided, though this is not a big surprise to us.

5) Due to promotional environment & inventory levels at competitors, higher cost shoes were discounted so heavily that they impacted sales at PSS’s “primary” brands.

Reasons to keep the faith
1) Price point is up, transactions are up, product mix is improving, customer scores are reportedly getting better. Weak traffic is the problem. If there was ever an environment to give a zero-square-footage-growth retailer the free pass on traffic, then this is probably it.

2) Very interesting to hear Rubell say that he’s never seen inventory more healthy. Inventory in dollars ended the quarter up mid single digits, but in units it was down single digits. Setting the stage for better gross margins in 2Q onward?

3) SG&A cost reductions better than expected ~$30mm of identified reductions in 2009 with more possible. We’re modeling SG&A down 3-4% in absolute dollars in 2009.

4) Sperry and Saucony continued double digit growth rates with category growth for Sperry and channel expansion for Saucony (Europe) promising.

5) Significant CapEx reduction (from $130 to $85) will boost FCF. Even with operating cash flow down by a third, FCF growth should still be positive for the year.


7) How I’m doing the math, the cash flow here should get total net debt down by 80% over the next three years. What does that mean? It means that today the EV/EBITDA multiple of 3.8x is nothing to write home about on the long side. But with debt coming down, we’re at 1.5-2.0x EBITDA 2-3 years out. At that point, we’re also looking at about 4x EPS. I’ll take that.

8) Timing considerations… In 2H, we see costs from China come down, duplicative DC costs come off, SG&A cuts, lower interest expense and tax rate, all at the same time we cycle very easy top line compares. When I put this in context of my view that cash flow for the group overall will begin to turn in 2Q/3Q (see my 3/5 note I’m Getting Fundamentally Bullish), and it starts to paint a nice multiple-expanding picture for PSS.

I’m definitely not throwing in the towel here. In fact, expect me to synch more with Keith on this one as it relates to his timing and sizing models for a potentially powerful long-term call.

Casey Flavin
Brian McGough

Dancing With The Shorts

"May you live to be 100 and may the last voice you hear be mine."
-Frank Sinatra

Yesterday was the most fun we've had in a while. As the market ramped higher in full percentage point increments, it developed a wonderful rhythm ... one, two, three... one, two three... and all of a sudden we were Dancing With The Shorts...

To understand how to Dance With The Shorts, one should have some experience in short selling. You learn how your partner breathes and moves. You learn where her confidence lies. You try to avoid her fears...

By now, we all know that this daily performance dance bounces to higher levels of volume during bear markets than in bull ones. But does the amateur short seller really understand the complexity behind what's happening underneath her feet? Let's consider the internals of the US market's foundation using a simple 3 factor model: price momentum, volume, and volatility:

1.      Price Momentum - never mind the silly guy in the cheap seats who is still trying to convince you that Dancing With Real Investors requires an exercise in valuation. The US stock market doesn't trade on valuation right now. It trades on price. As soon as price penetrated what we have modeled as an immediate term resistance barrier (706 on the SP500), the market really found its footing, and did what American Idol's Randy Jackson would call "blowing it out of the box!"... price momentum is critical to examine, because there are a lot of one factor model traders out there who chase price... once we shot through the 706 line, we immediately put the 755 line of the SP500 in play.

2.      Volume - on the NYSE yesterday, volume ran +33% higher versus the volume you heard out there on the dance floor on the evening prior (with the SP500 down -57% from her 2007 peak at 676, it got eerily quiet). When volume is decelerating in the face of price declines, and accelerating alongside on the UP moves, the short seller better beware. This is new, and doesn't signal another Great Depression.

3.      Volatility - as price momentum accelerated alongside positive volume, volatility (as measure by the VIX) broke her ankle. Yes, when Dancing With The Shorts, this is bad... if you are short, that is... Intermediate Trend line resistance in the VIX remains at 51.24, while the immediate term Trade support of 46.50 (shorter duration momentum) was penetrated to the downside yesterday, closing out the song with a final number of 44.37, which is -44% lower than the freak-out VIX levels of Oct/Nov 2008.

A lot of short sellers are new to being on the dance floor. Yes, the market having gone straight up from 2003 to 2007 had a stylistic impact. For whatever reason, I was fortunate enough to start my career on the buy side in 2000. Fortunate? Right, not so much if I was a levered long investor (the years 2000, 2001, and 2002 were all down years for the US market)... but very fortunate in having learned how NOT to get squeezed during bear market bounces.

I am a firm believer that one has to make a ton of mistakes in this business, using a live audience and marking oneself to market, before they should ever be so foolish to try to make a global macro "call" on the market every day like I have to... ask Jimmy Cramer how being in the fishbowl is treating him these days now that one of this country's finest entertainers (Jon Stewart) is taking him to task on what exactly it is that Jimmy does out there on the dance floor...

In Stewart's case, we have a credible entertainer who is reasonably transparent and accountable going after another entertainer who has issues with the same. It's sort of like Dancing With The Bears - to really pick them off, you have to have been one...

Back to the global macro playbook, I'm going to stay with the program rather than reiterate buying low beta Consumer Staples (Cramer's best idea was buying Hershey last night), and remind you of the BETA shift dance move that my Partner, Howard Penney, made a call on intraday to our Macro clients yesterday. As the music picks up its pace, and the volume accelerates, what you really should be doing is BETA shifting UP.  In effect, do the opposite of what Cramer The Entertainer recommends - buy higher BETA groups like Energy, Tech, and Basic Materials; short Consumer Staples.

I basically covered ALL of my shorts other than 3 positions by Monday's close. I have NEVER done that in my career. We can chalk it up to my being lucky again, and I am very cool with that. Being lucky these days is a lot better than being depressed.

The shorts that I had on yesterday acted great, on a relative basis to the Dancing that was going on out there with the shorts. I ended up with 5 virtual short positions, and they were as follows: short the US Dollar  (UUP), short Bonds (SHY and LQD), short Coke (KO), and short WMS.

WMS tagged me pretty good, and I deserved that. Unlike Coke and Hershey who miserably underperformed, WMS is high BETA, and charged higher with the ultra high BETA Gaming Sector. Good thing we were long names like WYNN, which more than offset that terrible timing decision I made to short WMS early this week.

No matter how good your investment ideas, everything has a time and a price. Ostensibly, all of the dancers on this floor are intelligent market participants. What will differentiate investors in this live Darwinian dance exercise from here will be the same thing that's always governed free marked-to-market performance. There will be winners, and losers. This is America, afterall... and as our Great American friend Frank Sinatra reminds us "You gotta love livin', baby, 'cause dyin' is a pain in the ass. 

May we all live and trade markets until we are 100!


EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months.  With interest rates at 3.25% (further room to stimulate) and a $26.5BN stimulus package in place, plus a commodity based economy with proximity to China's H1 reacceleration, there are a lot of ways to win being long Australia.

USO - Oil Fund- We bought oil on Friday (3/6) with the US dollar breaking down and the S&P500 rallying to the upside. With declining contango in the futures curve and evidence that OPEC cuts are beginning to work, we believe the oil trade may have fundamental legs from this level.

QQQQ - PowerShares NASDAQ 100 - We bought QQQQ on a down day on 3/2 and again on Friday of last week.

SPY - SPDR S&P500- We bought the etf a smidgen early, yet the market indicated close to three standard deviation oversold.

CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +17.4% for 2009 to-date. We're long China as a growth story, especially relative to other large economies. We believe the country's domestic appetite for raw materials will continue throughout 2009 as the country re-flates. From the initial stimulus package to cutting taxes, the Chinese have shown leadership and a proactive response to the credit crisis.

GLD - SPDR Gold- We bought gold on a down day. We believe gold will re-find its bullish trend.

TIP - iShares TIPS- The U.S. government will have to continue to sell Treasuries at record levels to fund domestic stimulus programs. The Chinese will continue to be the largest buyer of U.S. Treasuries, albeit at a price.  The implication being that terms will have to be more compelling for foreign funders of U.S. debt, which is why long term rates are trending upwards. This is negative for both Treasuries and corporate bonds.

DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.

VYM - Vanguard High Dividend Yield -VYM yields a healthy 4.31%, and tracks the FTSE/High Dividend Yield Index which is a benchmark of stocks issued by US companies that pay dividends that are higher than average.


LQD -iShares Corporate Bonds- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back. Moody's estimates US corporate bond default rates to climb to 15.1% in 2009, up from a previous 2009 estimate of 10.4%.

SHY -iShares 1-3 Year Treasury Bonds- On 2/26 we witnessed 2-Year Treasuries climb 10 bps to 1.09%. Anywhere north of +0.97% moves the bonds that trade on those yields into a negative intermediate "Trend." If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yield is inversely correlated to bond price, so the rising yield is bearish for Treasuries.

UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. The Euro is up versus the USD at $1.2691. The USD is down versus the Yen at 98.4950 and up versus the Pound at $1.3742 as of 6am today.

Eye on Commodities: Leading Indicators?

We wanted to highlight two commodity related charts here today. The first is the percent change of price levels of the SP500 versus copper and oil over the last three weeks. The second is the longer trend line for oil.

On the first chart, the last three weeks have seen an important signal from commodities as they outperformed domestic equities, even as the US dollar index has strengthened. This to us is an important early signal--just like semiconductor companies saying that “things are less bad”--that global demand is set to pick up from the lows of Q4 2008 / early Q1 2009. There is likely no better leading indicator than basic commodities like oil and copper, and their clear divergence versus domestic equities over the past three weeks is to be noted.

On the second chart, the point is to highlight that there is serious upside to oil on a breakout. Our quantitative model has oil’s trend resistance at $89.84 per barrel for West Texas Intermediate, which is more than 100% upside from the current price. Obviously oil testing that line is far from a foregone conclusion, but we would highlight a number of incrementally positive fundamental data points:

· OPEC – While this is very difficult to measure, media reports suggest that OPEC compliance with the 4.2MM in production cuts announced since September are now near 80% with the potential to reach 90% by the March 15th OPEC meeting. There are also some rumors that OPEC may cut an additional 500K – 1MM barrels per day at this meeting. According to BP’s most recent statistical abstract, world oil production is at ~81.5 million barrels per day, so a 4 – 5 million barrel cut is very significant.

· U.S. inventory building at a lesser rate – Days supply in the United States has increased for 9 straight weeks from December 19th to the week ending February 20th from 21.8 says supply to 24.9 days supply. In the week ending February 27th, we saw the first abatement of this trend as days supply declined sequentially to 24.8.

· China – On March 9th, Zhang Guobao (head of the Chinese National Energy Administration) said in published reports that China should use part of its nearly $2 trillion in foreign exchange reserves to buy more gold, oil, uranium and other strategic materials. Obviously the Chinese have a lot of buying power. If they were to allocate ~4% of their foreign exchange reserves into buying oil, they could buy 500K barrels, at the current price, every day for the next year. As Tim Russert says, that is BIG!

Modeling the projected supply / demand for the global oil balance is a complex endeavor, but focusing on changes on the margin and major shifts in the model (China buying, OPEC cutting production) are important and can impact the supply / demand balance meaningfully. And as we see in the chart below, there is a serious upside if demand begins outstripping supply, even in the short term.

Daryl G. Jones
Managing Director

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.52%
  • SHORT SIGNALS 78.67%

Beta Shifting - Up

Today in the Research Edge morning meeting for our clients we said that if the S&P rallied to 711, the next level of resistance would be 754. (We update our model every 90 minutes and the level has changed to an immediate term breakout/breakdown line of 705). Given the massive move we are seeing today, this could happen very quickly.

To gain Alpha in the move to 754, you need to beta shift away from the “safety play.” At the time of writing, the top three performing sectors today are the XLF (Financials), XLE (Energy) and the XLI (Industrials). The corresponding beta on those three sectors are 1.6, 1.2 and 1.04, respectively. The only other sector outperforming the S&P 500 today is the XLY (Consumer Discretionary), with a beta of 1.2. With a beta of 0.52, the XLP (Consumer Staples) is showing a massive negative divergence.

While MCD is not officially in the XLP, it is representative of the issues associated with global consumer product companies that comprise the XLP. Yesterday, MCD reported remarkably strong same-store sales, yet overall sales declined given the currency impact. While most investors like to look through the issues of currency, the strength in the US$ is a big negative for all of these global companies, creating negative year-over-year comparisons. Analysts don’t back out the impact of currency when modeling operating EPS. That being said, from a bottoms up perspective the collective street is modeling 12% operating EPS growth for the XLP; not going to happen given the economic and currency headwinds.

Where to look… The XLE (Energy) double bottom tested on Friday and saw further follow through yesterday and again today. The XLE continues to make sense with oil in positive “Trend” position. The US$ is declining today, therefore higher beta assets like commodities and stocks will “re-flate.” The XLB (Materials) is a major beneficiary of this trade.

We have cited numerous examples over the past week where fundamentally, things are looking less bad in 1Q09 from 4Q08. We continue to like early cycle Technology, Consumer Discretionary and Gaming stocks.

Howard W. Penney
Managing Director


Our consumer and macro team have noted signs of stability in our respective sectors. Things appear to be getting less bad. Is that enough for the stock market? Keith McCullough and our macro team believe so, at least for the near term. They believe we won’t hit resistance until 754 on the SPX, or 6% higher than here. Interesting call particularly if you believe, as we do, that the housing delta will turn positive in Q2. Keep a trade a trade is our motto since we all remain concerned with the quasi socialism that’s being proposed.

In my narrow world, we’ve seen evidence of stability. Today, we got some confirmation in two areas where I would’ve least expected it: lodging and Las Vegas. It wasn’t exactly a “business is booming” call to arms, but Starwood Hotels indicated at an investment conference that “the change in the rate of change has stabilized”. You know it’s a bad stock market environment when a positive 2nd derivative becomes an investable delta. The other surprise of the day was the RevPAR data provided by Sheldon Adelson. February occupancy and rate at their Las Vegas properties were 93% and $225, respectively, much higher than the Street was expecting for Q1. Moreover, March is a stronger seasonal month.

We do acknowledge that these are the first positive data points we’ve garnered on either general lodging or Las Vegas. However, we have been making the case for stability in other areas of leisure. We’ve been highlighting the sequentially improving regional gaming markets (see “REGIONALLY SPEAKING, BUSINESS AIN’T THAT BAD” from 2/18/09). PNK posted terrific earnings and the rest of the regional guys were better than bad. In our 2/26/09 note, “CRUISING TOWARDS STABILITY”, we discussed better Jan/Feb bookings.

In any other market, I probably wouldn’t be highlighting “less bad” as an investable theme. However, given the valuations on leisure stocks, rock bottom expectations, high short interest, and Keith’s near-term positive view on the market, any signs of stability are important.
I personally own shares of PNK

Where's Shorty? The VIX...

This morning, we are seeing more of the same. Volume accelerating on the stock market’s UP move as volatility (VIX) continues to break down (-9% on the day). These 3 factor (volume, price, and volatility) acting this way in unison are, on the margin, bullish.

The VIX in particular is forming a formidable bearish Trend at the 50.98 line (thick red line), and should accelerate to the downside if/when the VIX breaks the shorter duration Trade line (dotted red line) at 46.53. There is weak support for the VIX down at 43.42, and it should bounce there… but, make no mistake, the VIX is making lower highs (vs. the 2008 peaks) on rallies and strength in the VIX is to be sold.

Be careful on the short side out there. There are some angry bears out there dealing with today’s short squeeze who know this is the right quantitative call.

Keith R. McCullough
CEO & Chief Investment Officer

Early Look

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